Accounting, Analysis, and Principles ohnsonCoaccepts a note receivable from a cu

Question

Accounting, Analysis, and Principles ohnsonCoaccepts a note receivable from a customer in exchange for some damaged inventory. The note requires the customer make semiannual installments of $50,000 each for 10 years. The first installment begins six months from the date the customer takes delivery of the damaged inventory. Johnson's management estimates that the fair value of the damaged inventory is $679,517. Accounting (a) What interest rate is Johnson implicitly charging the customer?Express the rate as an annual rate but assume semian nual compounding. (b) At what dollar amount do you think Johnson should record the note receivable on the day the customer takes delivery of the damaged inventory? Analysis Assume the note receivable for damaged inventory makes up a significant portion of Johnson's assets. If interest rates increase, what happens to the fair value of the receivable? Briefly explain why. Principles The Financial Accounting Standards Board has issued an accounting standard that allows companies to report assets such as notes receivable at fair value. Discuss how fair value versus historical cost potentially involves a trade-off of one desired quality of accounting information against another.

Explanation / Answer

a. Interest rate charging to custumer

Present value = 679,517   Semi Annual Payment = 50,000

Formula = Present value = Annuity x ((1 - (1 / (1 + r) ^ n)) / r)

= 679,517 = 50,000 x ((1 - (1 / (1 + r) ^ 10)) / r)

= 679,517 / 50,000 = 13.59034 = ((1 - (1 / (1 + r) ^ 10)) / r)

= 13.59034 = ((1 - (1 / (1 + r) ^ 10)) / r)

= r = 0.04 = 4 %

Interest Rate = 4 %

b. Johnson should record note receivable on the day customer takes delivery of damaged inventory at its fair value that is $ 679,517 beacause first installment is not until 6 months after the date the damaged inventory.

c. Analysis If the interest rate increases, the fair value of the receivable will decrease because the higher the interest rate, the lower the future cash flows

d. Principles The trade off between historical cost and fair value is that historical cost is generally though to be verifiable and provides benchmarks for measuring historical trends, whereas fair value may be more useful in information about future cash flows related to an asset or liability.

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